Are Employee Benefit Trusts dead?
Her Majesty’s Revenue & Customs (‘HMRC’) just don’t like employee benefit trusts (‘EBTs’). UK companies usually set up their EBTs offshore, to benefit employees, former employees plus their families and dependents. Whilst this may sound laudable, HMRC see EBTs as a tax-avoidance ‘dodge’. HMRC tried to make them less attractive, particularly by restricting corporation tax relief on company funds going into EBTs, but still they flourished.
So HMRC ‘went nuclear’. Included in the draft Finance Bill for 2011, published on 9 December 2010, are major proposed changes to EBTs. The Bill is subject to consultation so the rules summarised below may be amended before they are enacted (expected July 2011). What is clear, however, is the extent to which HMRC do not want EBTs (and similar structures) to reduce the employee’s tax bill.
New disguised remuneration tax charge
A new tax charge will apply, from 6 April 2011, where a third party (not the employer) makes provision for a reward, recognition or loan in connection with the employment of an employee (or former or prospective employee). The tax is still payable if the employee is non-resident, but will be reduced to the extent the reward etc relates to non-UK duties.
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The new provisions are designed to catch EBTs (and Employer Funded Retirement Benefit Schemes or EFRBS) but are so widely drafted that they may apply to any employment reward arrangement which involves a third party, if that arrangement does not fall within the limited list of exclusions.
When does the tax charge apply?
The tax charge will apply to:
- sums or assets that are earmarked for employees by trusts or other intermediaries;
- loans provided to employees by trusts and other intermediaries; and
- assets provided to employees by trusts and other intermediaries.
Each of these ‘relevant steps’ will trigger the tax charge.
Anti-forestalling provisions are also included, to impose a tax charge if certain ‘relevant steps’ are taken on or after 9 December 2010 and before 6 April 2011. This tax charge will arise on 6 April 2012 to the extent that sums have not been repaid or assets returned before that date.
There is no definition of “earmarking” but the new rules stress this can be done informally and that it doesn’t matter if the employee has any legal right to the money or assets that have been ‘earmarked’. This will catch the allocation of funds from an EBT onto sub-funds, or sub-trusts, for the benefit of particular employees and their dependants. Equally, it seems to cover the contribution of funds into an EFRBS or offshore pension because the trustees usually allocate the funds between members upon receipt.
The rules also catch making an asset available for use without a physical transfer, where the benefits are “substantially similar”, e.g. the use of a holiday home.
The tax charge is on the value of the ‘relevant step’ e.g. the amount of cash involved. In non-cash cases, the value is the higher of the market value of the asset in question or the cost of the relevant step. The value of the ‘relevant step’ is treated as employment income and is subject to income tax (under PAYE). Regulations will be introduced to apply NICs to the amounts charged to tax under this new rule. In other words, anything caught by these new rules will be taxed in the same way as a salary or bonus.
Provisions are included to avoid a double tax charge where there is more than one relevant step but loans are particularly problematic. When a loan is made, the whole amount of the loan will be taxed as employment income (even if the loan carries interest). There are no provisions explaining what happens if the loan is later repaid.
What exemptions apply?
Certain arrangements are not caught by the new legislation, including approved share/option schemes and transfers to registered pensions. Trusts that are set up for the sole purpose of providing benefits in respect of ill health, disability or death are also excluded.
A power is included for HMRC to introduce regulations (which may be retrospective) to extend the exemptions to certain relevant non-UK pension schemes. This would include Qualifying Recognised Overseas Pension Schemes (QROPS). Until such regulations are made, however, any such scheme would seem to be caught by the new tax charge.
Certain loans are excluded but only those which:
- are made on ordinary commercial terms by a person whose normal business includes the lending of money or the supply of goods or services on credit; and
- are not connected (directly or indirectly) with an arrangement which has a tax avoidance purpose.
Employee benefit packages are excluded if they are offered in the ordinary course of business and:
- substantially all of the employees can take advantage of what is offered;
- such employees are not wholly or mainly directors, senior employees or highly paid employees; and
- the benefits are not connected (directly or indirectly) with an arrangement which has a tax avoidance purpose.
This would exempt, for example, private health cover offered to all employees.
The new rules should not apply to pre-existing arrangements (e.g. where money has already been paid to an EBT or where loans have already made been to employees). If, however, a relevant step is taken now, e.g. a new loan is made, then the new rules may apply.
Anyone with an EBT, or who was thinking of setting up an EBT, should get urgent advice before 6 April 2011.
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